American Housing Month

As June is American housing month, I thought I would address a topic I get asked a lot when doing financial planning with clients:

Should we pay off our house before we retire?

The simplest answer is the same as it is for most financial questions: It depends.  It depends on you – your finances, and your views/feelings on debt.

Let’s look at the finance side of things first.  Here’s a chart of 30 year mortgage rates going back to 1990:

As you can clearly see, rates are well-below the average of the past 30 years.  And this doesn’t even take into account the early 80s where you were over 15%.  If you bought or refinanced your home at any point within the last 8-9 years, you are likely under 5% interest on your mortgage.

What many people assume, is that by paying off their loan sooner, they will be saving themselves a lot of money in interest.  This is common mistake.  Mortgages are amortized loans.  In basic terms, this means that the first few years payments are mostly interest, whereas the last few are mostly principle.  Let’s do some quick math:

Loan amount - $300,000

Term – 30 years

Rate – 5%

The first year, you will have paid roughly $19,320 in payments, with $14,900 being interest.  That’s 77% of your payment going to interest.  The last year you will still have paid $19,320, but this time only $514 in interest.  That’s now less than 3% of your payment going to interest.  By paying your mortgage off early, you save yourself 3%.  Is that the best use of your capital?

Now comes the hard part though – Your View/Feelings on debt.  Many people don’t like debt.  Maybe they’ve had a bad experience with it themselves, or know someone who has.  Dave Ramsey makes the elimination of debt a major part of his teachings, going so far as to have his followers scream out “I’M DEBT FREEEEEE!!!!”.  For these people, the financial side does not matter as much.  How much value do you put on piece of mind?

So should you pay off your mortgage?  It depends.  Meet with your advisor and have a thorough discussion on the positives and negatives or each option, and figure out what works the best for you.  There only right answer, is the one that is right for YOU.